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Luukko: Low interest rates are bullish for bullion

There’s no shortage of pundits who say the price of gold could reach new records, as it did earlier this month.

But about all we can say for certain is that bullion—which at $1,327 (all gold prices U.S.) at mid-week has roughly doubled in price since August 2007 – has a hard act to follow.

Gold’s spectacular surge has been a bonanza for holders of precious metals equity funds. Gold-mining stocks, and funds that invest in them, are leveraged plays on bullion, with bigger gains or losses than the metal itself.

The median return for funds tracked by Morningstar in the precious metals category is 53.5 per cent over the past 12 months ended in September. These funds also dominate the list of the top five-year performers, with an annualized 19.3 per cent return for the median fund.

If you’re seeking a pure play on gold, you can do so by buying bullion, gold coins or gold certificates. Or you can buy a bullion fund such as Sprott Gold Bullion and BMG Gold Bullion, the closed-end Sprott Physical Gold Trust (PHY/TSX) and the exchange-traded fund Claymore Gold Bullion (CGL/TSX).

Should you go for gold? As history shows, gold bullion can make sharp moves in either direction. During the two-year period ended in October 1989, for instance, the price of gold fell by about 30 per cent. Hold too much gold at the wrong time, and you could do serious damage to your net worth.

Cautionary tales aside, gold bullion has a place in diversified portfolios as a store of value and as a hedge against inflation, market shocks and currency weakness. Among the money managers who find gold attractive, even at its current lofty levels, is Stephen Lingard, co-manager of the $7.7-billion Quotential program sponsored by Franklin Templeton Investments Corp.

The Toronto-based Lingard says the eight Quotential portfolios each have exposure to gold bullion, ranging from three to four per cent of assets.

“We’re finding a place for gold in every situation,” he says, noting that the Quotential portfolios’ objectives range all the way from conservative income-focused to 100 per cent equity.

At the same time, gold is not considered a core holding for the Quotential portfolios. The price has to be right. “If gold goes up another $500 or $600 or more, we’d have no problem eliminating it from the portfolios,” Lingard says.

Elsewhere, the managers of the Invesco Intactive portfolio funds are contemplating whether they might want to add to their holdings in gold.

Securities regulations allow funds to hold up to 10 per cent of their assets in commodities such as gold, and fund sponsor Invesco Trimark Ltd. is seeking a regulatory exemption to double the Intactive funds’ limit to 20 per cent.

“We feel we have sufficient room (to hold gold) for the time being, but we want to make sure we have plenty of flexibility,” says Scott Wolle of Invesco Advisers Inc. He heads the Atlanta-based team responsible for managing the asset mix for Intactive funds, some of which currently hold eight to nine per cent of their assets in gold.

One of the disadvantages of holding gold—as opposed to bonds or dividend-paying stocks—is that gold pays no interest or other income.

But in the current interest rate environment, the opportunity cost of holding gold is low. As Wolle observes, periods when real (after-inflation) interest rates are less than two per cent—like now—tend to be bullish for bullion.

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